zen technologies ltd share price Management discussions

Global Economy

The global economy experienced a period of disruption and volatility in recent years, marked by a pandemic, trade wars, rising inflation and geopolitical confrontations. As we move into mid-2023, we find ourselves facing a set of challenges that feel both unfamiliar and unprecedented.

Despite these challenges, there are reasons to be optimistic. Central Banks across the world are expected to signal interest rate cuts, which should result in a sustained recovery of asset prices and the economy by the end of 2023. In order to execute a shift in policy, a confluence of factors must arise, including a heightened state of economic vulnerability, a marked uptick in unemployment rates, intensified market turbulence, a depreciation in the value of high-risk assets, and a contraction in inflation levels. These circumstances, however, are poised to engender a variety of potential hazards in the short-term. Amidst the persistent headwinds, the global economy has demonstrated remarkable resilience towards the end of 2022, dispelling the apprehensions of a protracted downturn. A pleasant surprise in numerous economies, including the US, the Euro areas, and major emerging markets, was the unexpected strength of the real GDP. In many cases, the underlying sources of this robustness were domestic, driven by the remarkable resilience of private consumption and investment, along with favourable fiscal stimulus.

The tight labour market and pent-up demand for services created a unique window of opportunity, which the households were quick to capitalise on by dipping into their savings. The upward trajectory of business investment further consolidated this expansion, indicating a growing sense of confidence in the future outlook. Additionally, it is also noteworthy that the energy markets adjusted with remarkable agility to the shock from Russias invasion of Ukraine, which further bolstered the growth momentum.

OUTLOOK

As the global economy navigates unprecedented challenges, it is imperative that businesses adopt an informed and strategic approach to achieve sustained economic stability and growth. Policymakers are expected to prioritise disinflation and consider deploying macroprudential tools and strengthening debt restructuring frameworks. Further, the acceleration of COVID-19 vaccinations can act as a safeguard to the recovery, and enable businesses to better respond to these challenging circumstances.

The gradual withdrawal of broad-based fiscal relief, followed by focused fiscal measures, can aid those most affected by elevated food and energy prices. Moreover, stronger multilateral cooperation can help preserve the gains from the rule-based multilateral system and mitigate climate change by limiting emissions and making substantial green investments.

Indian Economy

Following growth of 8.7% in FY2022, the Indian economy witnessed a growth of 7.2% in FY2023, surpassing market expectations. This can be partially attributed to the high credit growth, averaging over 30.5% to the micro, small, and medium (MSME) sector. Moreover, in the first eight months of FY2023, the central governments capital expenditure surged by 63.4%, thus becoming a key growth driver.

Factors such as robust private final consumption expenditure, export incentives, heightened investment demand due to public capex, and improved bank and corporate balance sheets, which collectively fuelled industrial expansion, also contributed to the resilience of the economy.

During the fiscal year, there was a significant surge in bank credit, which grew at an impressive rate of 15.4% Y-o-Y, primarily driven by increased lending to the retail and services sectors. The strong demand for credit was evident in all segments, encompassing a mix of term loans and working capital. In contrast, deposit growth remained more subdued, registering a growth rate of 9.6% Y-o-Y. This slower growth in deposits was mainly attributed to the gradual drainage of surplus system liquidity that had been injected by the Reserve Bank of India (RBI) during the pandemic period. The combination of high credit demand and relatively restrained deposit growth posed a unique challenge for the banking sector. The banks had to carefully manage their resources and liquidity to meet the growing credit requirements while ensuring stability and financial prudence.

Even though private consumption, supported by a rebound in contact-intensive services stood, at 58.4% of GDP, the World Trade Organisations lower growth forecast of global trade from 3.5% in 2022 to 1% in 2023 has the potential to impact the countrys growth trajectory.

OUTLOOK

The Reserve Bank of India (RBI) anticipates Indias growth rate to moderate to 6.5%. This adjustment in the growth forecast is influenced by the IMF slightly lowering its growth projection for 2023. Additionally, there is an expectation of a deceleration in global trade of goods and services due to efforts to control inflation through higher interest rates.

Despite these challenges, the G-10 central banks, which are nearing the peaks of their respective rate hike cycles, are expected to have a positive impact on the Rupees stability. This factor could potentially offset some of the adverse effects arising from the moderation in economic growth and global trade slowdown, providing some support to the countrys currency and overall economic outlook.

Continued focus on capital expenditure by the government will attract private sector investment gradually. Bank credit growth is expected to moderate due to the economic slowdown, reducing the gap between credit and deposit growth. Nonetheless, deposit growth is likely to improve slightly, supported by higher interest rates as an incentive and anticipated system liquidity enhancement in the second half of the year.

(Sources: The RBI, IMF, NSO)

Indian Defence Industry

The Indian Defence sector, recognised as the second largest armed force in the world, is on the precipice of a significant transformation. Under the visionary Atmanirbhar Bharat initiative, the Government of India has singled out the defence and aerospace sector as one of the primary areas of focus. The principal objective is the creation of a robust indigenous manufacturing infrastructure that is backed by a comprehensive research and development ecosystem. This initiative not only serves the national security objectives but also propels India into a prominent global role. The ambitious goal set by the government is to achieve a turnover of $ 25 Billion, including export of $ 5 Billion in aerospace and defence goods and services by 2025. India is already on a steady path towards this goal, with defence exports reaching an unprecedented level of ~ H 16,000 Crore in FY2023, marking a remarkable tenfold increase since FY2017. The massive surge in exports, alongside the governments steadfast push towards self-reliance, paints an optimistic future for the sector. It is imperative to recognise the governments targeted financial commitments that underscore this transformation. As the third-largest military spender worldwide, India has allocated 2.15% of its GDP to its defence budget. Moreover, an increased allocation of H 5.94 Lakh Crore in FY2024, marking a jump of 13% over the previous year, serves as further evidence of the governments dedicated resolve towards this sector.

Looking ahead, the Government plans a massive investment of $ 130 Billion over the next 5-7 years for fleet modernisation across all armed services, thus demonstrating its commitment to reinforcing Indias position in the global defence landscape.

Furthermore, to stimulate the domestic defence industry, the government has been proactive in ensuring an enabling environment characterised by transparency, predictability and ease of doing business. This approach is bolstered by robust policy support, as reflected in the 606 Industrial Licences issued to 369 companies operating in the Defence sector until April 2023.

11.3

($IN BILLION)

INDIAN DEFENCE SECTOR MARKET SIZE

2.15%

INVESTMENTS IN R&D IN THE LAST 5 YEARS

15%

SHARE OF GLOBAL ARMS IMPORT

13%

INCREASE IN ALLOCATION DEFENCE BUDGET

Sector Policies

The Government of India has further demonstrated its commitment to the defence and aerospace sector by formulating a set of comprehensive and strategic policies, aimed at bolstering the growth and development of the industry. These policies provide a structured and reliable environment, essential for the industrys progression, while also aligning with the broader national vision of self-reliance.

PROCUREMENT POLICY

Defence procurement is regulated by the Defence Procurement Procedure (DPP). The DPP is committed to institutionalising, streamlining, and simplifying the defence procurement process to bolster the “Make in India” initiative.

OFFSET POLICY

The primary objectives of the defence offset policy are to capitalise on capital acquisitions to cultivate the domestic defence industry. This policy requires foreign defence participants to offset a minimum of 30% of the procurement of defence equipment. This is applicable for categories of procurement where the estimated cost of the acquisition proposal is $ 286.04 Million or higher.

INDUSTRIAL LICENSING PROCEDURES

The duration of the initial industrial licences has been extended from 3 years to 15 years, with an option for a further extension of 3 years. Guidelines for the extension of the validity of industrial licences have been put in place. The initiation of production of any item covered by the licence is now considered as the onset of production for all items included in the licence.

DEFENCE ACQUISITION PROCEDURE (DAP)- 2020

DAP 2020 supports the indigenous design and manufacture of defence items. The Make Procedure strives to achieve self-sufficiency by promoting greater involvement of Indian industries, particularly the private sector. The Make-I (Government Funded) category pertains to design and development of equipment, systems, significant platforms or their upgrades by the industry, where the Ministry provides financial backing of up to 70% of the prototype development cost or a maximum of H 250 Crore per Development Agency (DA). The Make-II (Industry Funded) category encompasses design, development, and innovative solutions by an Indian vendor, with no Government funding, but an assurance of procurement upon successful prototype development.

DEFENCE TESTING INFRASTRUCTURE SCHEME

This scheme is devised to enhance domestic defence and aerospace manufacturing by allocating H 400 Crore for the creation of top-notch testing infrastructure in collaboration with the industry. The scheme was launched by the Defence Minister in May 2020.

INNOVATIONS FOR DEFENCE EXCELLENCE (IDEX)

Introduced in April 2018, iDEX is an innovation ecosystem for Defence. It aims to nurture an environment that encourages innovation and technological progress in Defence and Aerospace. This is achieved by involving Industries, MSMEs, Start-ups, Individual Innovators, R&D institutes, and Academia and offering them grants, funding and other support for R&D that has potential for future use in the Indian defence and aerospace sectors. As of February 2023, 139 iDEX winners have received grants and funds, with an allocation of H 1,000 Crore for iDEX-related purchases and an additional H 500 Crore set aside to back start-ups over the subsequent five years.

DEFENCE PRODUCTION AND EXPORT PROMOTION POLICY 2020 (DPEPP)

The Ministry of Defence (MoD) has outlined the draft DPEPP 2020 as a guiding document to provide a structured and significant impetus to the countrys defence production capabilities for self-reliance and exports. This includes a focus on establishing an Aero Engine Complex for civil and military uses and developing core technologies for Aero Engines, leveraging favourable tax rationalisation measures to stimulate the Maintenance, Repairs & Overhaul (MRO) sector, and developing R&D strategies for achieving indigenisation of listed Critical Technologies and Materials.

MD&A

Simulation Industry

Military simulation training, employing modern technology such as artificial intelligence, virtual reality, and computer-based simulations, provides an effective platform for the replication of weapon systems, combat situations, and the overall environment of warfare. These simulations offer a realistic training experience, enhancing operational readiness.

With its cost-effectiveness and relevance, simulation training is increasingly favoured for military personnel training across air force, army, and navy. It provides a secure, immersive environment that aids in honing decision-making skills and response mechanisms, preparing trainees for real-life scenarios. The global military simulation and training market size is projected to grow at a CAGR of 6.2% from 2020 to 2030, from an estimated $ 11.56 Billion in 2022 to an estimated $ 20.58 Billion by 2030. This growth trajectory can be attributed to the rise in defence expenditure worldwide and technological advancements aimed at strengthening military capabilities.

In India, the simulator market is estimated at H 15,000 Crore. The Indian government is taking strides to bolster indigenous manufacturing, and the Ministry of Defences recent policy framework is a testament to this initiative. It underscores enhanced utilisation of simulators across all arms of the defence services, potentially creating a surge in demand.

Company Overview

Zen Technologies Limited, a leader in the defence technology sector, manufactures advanced simulator training solutions and anti-drone systems. We serve a diverse range of 100+ institutional clients, including the Ministry of Defence, the Government of India, and its Armed Forces, Security Forces, and Paramilitary Forces. Our product portfolio consists of land-based military training simulators, driving simulators, live-range equipment, and anti-drone systems. Our R&D facility has been recognised by the Ministry of Science and Technology, Government of India. Our robust R&D capabilities, coupled with our state-of-the-art production facility in Hyderabad, have enabled us to apply for over 130 patents and ship more than 1,000 training systems across the globe till date.

Opportunities

MILITARY TRAINING

The Ministry of Defence (MoD) rolled out a comprehensive simulation framework aimed at enhancing the utilisation of simulators by the Armed Forces and the Indian Coast Guard. The overarching objective of this initiative is to foster a shift towards simulation-based training across all military domains. This strategy is devised to achieve cost-effective, efficient, safe, and smart training, thereby boosting operational readiness while concurrently preserving equipment life and reducing expenditure. Our products align perfectly with the MoDs new vision, making us well-positioned to contribute significantly to this transformative shift in military training.

AGNIPATH INITIATIVE

Agnipath represents a substantial recruitment reform for the Indian Armed Forces. This initiative encourages patriotic youth, known as Agniveers, to serve the country. The objective of Agnipath is to reinvigorate the Armed Forces with youth and help it transition towards enhanced technological proficiency. The programme has received a robust response, with over 54 Lakh registrations across all three Services - the Indian Army, the Navy, and the Air Force. A crucial aspect of Agnipath is the requirement for an effective and efficient training system. To accommodate the shorter training period and still ensure comprehensive preparation, the reliance on state-of-the-art simulators and training systems is paramount.

As an industry leader in defence technology, we are perfectly poised to provide the solutions required by this program. Our expertise and experience in creating advanced training systems offer a significant advantage in seizing this opportunity. The prospect of aiding the training of Agniveers also aligns with our goal of contributing to national defence preparedness.

DRONE THREATS

Drone technology has emerged as a game-changing factor in modern warfare and security scenarios. Theres a growing trend of drone utilisation for offensive operations, posing significant threats to national security. These unmanned aerial vehicles (UAVs) have been used in numerous recent conflicts, indicating a shift in the tactics of warfare.

In this context, theres an urgent and growing demand for effective counter-drone technologies to protect important strategic assets like military bases, refineries, airports, and other critical infrastructure. Such systems are pivotal in detecting, tracking, and neutralising incoming drone threats, thus ensuring the security of our nations and their crucial installations. Given these factors, investment in developing and deploying robust counter-drone solutions represents a substantial opportunity for us.

Financial Performance

KEY FINANCIAL RATIOS

[Pursuant to Schedule V (B) to the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015, as amended]

RATIO	FY23	FY22	% CHANGE	REASON FOR VARIANCE
Debtors Turnover	3.77	2.91	29.56%	Due to Significant increase in revenue from operations whereas the trade receivable ratio did not reflect a proportional rise that can be attributed to the fact that the substantial portion of the sales made during this period were covered by advance payments received from customers
Inventory Turnover	1.48	0.72	103.77%	Due to normalizing of inventories based on the increase in capacity utilisation in the current year.
Interest Coverage Ratio	26.64	2.53	952.96%	The increase in EBIT on account of higher sale during the year, with Interest expense remaining relatively similar to that of last years expense let to such high improvement in Interest coverage ratio.
Current ratio	2.69	4.09	(34.23%)	There is an increase in advances received from customers. As a result, there is an increase in Current Liabilities and decrease the current ratio from Previous year.
Debt- Equity Ratio	0.02	0.04	(56.37%)	With the reduction in total debt during the year and increase in shareholders equity on account of higher profits despite adjustment of treasury shares during the year, the ratio has decreased compared to previous year.
Operating Profit Margin	34.62%	22.47%	54.07%	Due to increase in revenue from operations with better operation performance lead to increase in Operating profits during the year
Net Profit Margin	23.31%	3.77%	518.75%	Due to new orders, favourable market conditions which resultant to increase in revenue from operations with better operation performance leads to increase in net profits during the year
Return on Net- worth	12.32%	0.70%	1660.00%	Improved due to increase in PAT on account of increase in Revenue from operations, relatively lower fixed overheads.

Outlook

As of March 31, 2023, we secured contracts worth ~ H 473 Crore and have already won orders worth H 700 Crore in Q1 FY2024. We have also bid for several orders during FY2023 and are expecting positive confirmations before September 30, 2023. Our focus is on efficiently executing these orders within the next 18-24 months.

Over the next 5 years, we target a robust growth rate of 50-60% CAGR, aspiring to become a global leader in training and simulation, and anti-drone solutions. To achieve this, we have planned heavy investments in increasing the range of simulators on offer, achieving top-gun status in anti-drone solutions and exports initiatives. We also aim to expand our AMC business to H 150 Crore by 2027, mainly driven by sales in the next couple of years. To support our growth, we are looking to expand our footprint in global markets and increase exports. We have already established a demo centre in the UAE and plan to invest ~ H 15 Crore for another centre in the Middle East. A robust production and supply chain are essential, and we intend to invest in increasing production capacity and expanding our supplier base through outsourcing. To attain our objectives, a strong production and supply chain is crucial. We will invest in expanding production capacity and broadening our supplier base through outsourcing to strengthen our model. R&D remains a top priority, with a focus on enhancing technical capabilities Tentative capital expenditure, based on emerging opportunities, for both organic and inorganic growth over the next 2 years, is in place. Additionally, we are exploring opportunities to collaborate with Indian OEMs for the development of simulators.

Threats and Mitigation

PARTICULARS	RISK	MITIGATION
COMPETITIVE RISK	Our operations and profit margins might be at risk due to escalating competition and aggressive pricing strategies by international competitors. These firms may significantly drop their prices to secure a larger market share in India.	We continually strive to offer superior quality products and innovative solutions, enhancing our value proposition. We also leverage our strong, long-term relationships with our clients, focusing on their specific needs and requirements.
MACROECONOMIC RISK	Unfavourable macroeconomic conditions, such as a pandemic, could pose a risk to our Company. In such circumstances, governments may shift their focus to immediate concerns and possibly de- prioritise defence training.	We maintain a flexible business model, which enables us to adapt to changing macroeconomic conditions. Furthermore, our diversification into newer geographies also helps us mitigate this risk.
CLIENT COMMITMENT RISK	Much of our simulator production is based on specific client feedback, with no guaranteed purchase of the end product. This scenario places us at a substantial financial risk.	We always strive to ensure clear and upfront agreements with our clients. We focus on client engagement and maintain transparent communication about the product and service expectations and terms.
BIDDING RISK	The standard governmental policy of procurement from the lowest bidder could pose a threat to our Company. Occasionally, other vendors, having already amortised their development costs, can offer cheaper solutions due to their larger capacity.	We maintain a relentless focus on cost-efficiency and innovation in our operations, enabling us to compete effectively even in a low-bid scenario.
GOVERNMENT DEPENDENCY RISK	We at Zen Technologies heavily rely on the Indian Government for a significant part of our business, whether its policy-driven or pertaining to actual product sales.	We are consistently exploring and venturing into new product categories, new markets and customer segments to reduce our dependence on any single customer.

Human Resource Development and Industrial Relations

At Zen, we firmly believe that our employees are central to our accomplishments and progress. Over the years, we have steadfastly invested in the skill enhancement of our workforce through a myriad of training programmes and workshops, paving the way for their professional development. Alongside this, we have been proactive in attracting and preserving top talent within our ranks. Throughout the year, we have maintained productive and collaborative relationships with diverse stakeholders, such as suppliers, partners, customers, and of course, our own team members. As of March 31, 2023, we had a workforce of 280+ individuals, with an average age of 33.5 years, ensuring a beneficial blend of fresh perspectives and experienced insights.

Internal Control Systems and Their Adequacy

At Zen, we have established a comprehensive system of internal controls, tailored to align with the size and scope of our operations. Weve laid down a clear organisational structure with defined delegations of authority across our corporate functions. These are supported by documented policies and procedures that highlight our objectives and operational benchmarks. Our internal controls are structured to provide reasonable assurance of operational effectiveness and efficiency, safeguard our assets from unauthorised use or losses, ensure the reliability of financial controls, and maintain compliance with applicable laws and regulations.

Our internal control systems are in sync with our organisations scale, operations, and complexity. These systems, encompassing all key business areas, are periodically verified and tested by certified external auditors, as well as our internal audit team. An internal audit system reviews the effectiveness and adequacy of the control environment and ensures proper safeguards are in place. Routine audits are conducted in compliance with certifications ISO

9001:2015 (QMS), ISO/IEC: 27001:2013 (ISMS). An ongoing monitoring system guarantees the security of all data and information against unauthorised access.

The efficiency of internal controls is evaluated via our internal audit process, which covers all major corporate support functions under the leadership of the Head Internal Audit. These reviews are centred around identifying weaknesses and areas for improvement, checking for compliance with defined policies and processes, safeguarding tangible and intangible assets, managing business and operational risks, and ensuring compliance with applicable statutes and the Zen Code of Conduct.

Our Audit Committee, consisting of Zen Technologies Board of Directors, regularly monitors the adequacy of the internal control. They do this by consistently reviewing audit findings and supervising the implementations of internal audit recommendations. A summary of the critical elements of the internal controls includes routine reviews by the Audit Committee comprising Independent Directors, regular examinations by an independent internal audit team, and continuous reiteration of Zen Technologies Code of Conduct across the organisation.

Our Board is responsible for the overall process of risk management for the Company. In FY2023, we evaluated the effectiveness of our internal financial control over financial reporting and have instituted adequate internal financial controls with reference to financial statements, commensurate with the size, scale, and complexity of our operations. During the year, such controls were tested and no reportable material weaknesses in design or operation were observed.

Cautionary statement

The assertions presented in this section outline the Companys objectives, projections, expectations and estimations, which might be construed as forward-looking statements under the applicable Securities Laws and Regulations. Such forward-looking statements are constructed upon certain presumptions and projections of forthcoming circumstances. The Company cannot assure that these presumptions and projections accurately reflect future outcomes. The actual results could significantly deviate from those mentioned or suggested in the statements due to the impact of external factors that are beyond the Companys control. The Company is not obligated to make public alterations, adjustments or revisions to any forward-looking statements based on the occurrence of any later developments, information, or events.